We get a lot of questions about whether you should charge interest on a loan to a friend or a family member. And, how much is considered fair, or do you add on any at all?
How lending money helps the people around you.
Here’s what we’ll cover:
- Do you have to charge interest on friendly loans
- How lending money can help people that you know
- Interest rates comparison between investments and borrowing
- How to agree with the borrower on how much interest has been charged
Do you have to add on interest to a friend and a family loan?
No, you do not need to charge any interest on a loan to a friend or family member for it to be considered a loan. As long as the money has been lent with the intention for it to be repaid, it's considered a loan and not a gift. If you want to charge interest you are free to do so - but it’s important to note that any interest that is charged may be subject to income tax.
Click here if you need to send a Self Assessment tax return.
How lending money helps the people around you
Data suggests that there may be over £1 trillion of savings in UK bank accounts and ISAs. The banks are then lending out this money as loans and investing it to make more money. So, instead of the banks making a profit from your money. So, instead of them making a profit from your money, could you lend it to someone yourself and help someone out?
Sure there are other ways of borrowing money. You can get personal loans from banks, you could use credit cards or you could dip into your overdraft, but the interest rates on these are typically higher than loans given from friends and family. And they can have high credit score thresholds for the best rates. Meaning you may only be accepted for a much higher representative APR rate than is advertised.
Data shows that adults with poor credit scores are at risk of paying almost £700 more interest on credit cards than those with good credit scores.
For a credit card balance of £2,472, having a poor credit score means you could pay almost £60 extra a month compared to those with a good credit score, according to a recent report.
Having a poor credit score doesn’t just mean you are charged higher interest rates. It also means you have a smaller selection of products available to choose from, you receive lower credit limits and you benefit from introductory offers for a shorter period of time. All things that don’t help when you’re in a tough financial situation and need cash in a hurry.
People sometimes refer to debt as a slippery slope, you need cash quickly so you borrow at a higher rate than you can afford as a quick fix, the repayments take up more of your spare cash and you need to borrow more to get out of the hole and so on.
Lending to your friends and family can help them borrow money at more affordable rates than they’ll get from mainstream lenders. There is also no need for a credit check so applying won’t leave a mark on your credit score (yes believe it or not even applying for a loan or credit card with a traditional lender can show up as a negative mark on your credit score).
If you choose to use Punk Money to make a loan, repayments can go towards helping improve your credit score, so that you’re in a better position to apply for other financial products in the future.
Should I charge interest for lending money to friends and family?
This is entirely your decision. It depends on how much you are lending, how long for and the sacrifice you’re making. If you have to take your money out of a savings account you may want to charge the same amount or more so that you're not out of pocket.
To give some context and to help you decide how much interest you could expect from other saving options. Let’s break down how the rates offered by different saving accounts.
What are the standard interest rates for different savings option?
If you leave your money lying around in your current account, you could earn just a little as 0.5% interest on the money you have there. The problem here is - this is far less than the current inflation rate. Meaning the cash in your account is losing purchasing power (value). It’s best to always take a look at the options you have. There are lots of choices today from traditional savings accounts to higher-risk investment choices. We’re going to break down the traditional options.
A savings account is an account for you to put money in and earn interest. Savings interest is paid tax-free and most won't pay any tax on it at all. The benefit here is that savings are covered by the FSCS, which means in the event of the lender going bust, you would get £85,000 per person protection or £170,000 for joint accounts. Lending to Friends and Family isn’t covered by the FSCS, so you may want to consider how confident you are that the borrower can afford to repay you before you agree to the loan.
Cash ISAs are savings accounts you do not have to pay tax on. Everyone in the UK aged 16 or over gets an ISA allowance at the start of each tax year. For 2022/23, which ends on 5 April 2023, it's £20,000.
These figures were accurate at the time of publishing, but may change with the current market conditions.
Savings rates at a glance
Current Account: Around 0.5% on money sitting in your current account
Fixed and easy access savings account: Up to 2.5% easy access or up to 4.6% on fixed rate savings accounts
Regular savings accounts: Banks generally offer rates of 1% - 5.12% on regular savings accounts
Cash ISA: Up to 1.9% easy access or up to 4.25% fixed
How much does it cost to borrow money today?
Some of the most common ways to borrow money in the UK are through personal loans or on credit cards. The cost of this is different for borrowers because the rate which borrowers qualify for is dependent on their credit score.
Personal loans (or unsecured loans) are where you borrow a sum of money from a lender, and agree to pay it back over a set time period in fixed monthly repayments. The lender will charge you interest as its fee to lend money to you. You then repay the amount you borrowed plus interest. Personal loans typically are for larger sums over £1000 and are repaid over one year or more. They're great for large purchases or emergencies but are usually difficult to access for people with lower credit scores.
With a credit card, you’re basically promising your card provider that you will repay the money you owe at a future date, usually with interest added. They're easy to use and can help you build your credit score, however they're an easy way to get trapped in debt. If you can't pay off your credit card balance, high amounts of interest can be added which can spiral out of control.
If you have a current account, you probably have the option of an overdraft. An authorised overdraft is one you have applied for and had approved by your bank. An unauthorised overdraft is one your bank may let you use even though you haven’t applied for it. Overdrafts can be flexible and quick to arrange. As you only borrow what you need at a time, they can be cheaper than a loan.
If you’re struggling to get a loan, guarantor loans offer an opportunity to borrow, with the help of a guarantor. A family member or friend ‘guarantees’ to cover your payments if you fail to repay them. These loans are typically for larger sums of money (over £2,000).
High cost short term credit products are defined as loans that have an APR equal to larger than 100% and are usually repaid within 12 months. These are usually for people with bad credit scores who are finding it difficult to be accepted for any other credit or loan product (think payday loans).
Short term loan rates vary massively. Anywhere from 80% APR representative up to over 500%.
Borrowing rates at a glance
Personal loans: Rates are 10.4% - 18% for amounts between £1-£2,000 for 1 year.
Credit Cards: Rates from 17% for good credit up to 27% for poor credit
Overdraft: Arranged and unarranged overdrafts have a typical interest rate of 34% - 39% APR.
Guarantor loans: Rates from 29.9% APR to 49.9%.
High Cost Loans: High cost loans can be between 89% to over 2000% APR representative.
How to agree with the borrower on the interest rates charged?
When lending money to a friend or family member, both parties must be happy with the agreement. The interest charged for the amount borrowed will likely play a large role in this. Here are three things to think about:
What are the borrowers outgoings and incomings? This will determine how much they can afford to repay each month, and for how long. Think carefully when charging interest, the higher percentage you add on, the greater the risk becomes for not being paid back.
The opportunity cost
Where are you taking the money you are lending from? If you are taking it out of a savings account or had to pay a fee to take it from a fixed-term account you may want to recoup these potential losses with the interest you charged.
Use other products as a guide
The benefit of a friend and family loan is that it’s typically going to be a lot cheaper than loans someone can get from the bank or high street lender. However, you can use the rates charged by mainstream lenders as reference point in guiding you to a fair rate. The interest rate you charge is the cost of borrowing, but it should be fair.
On the Punk Money platform, lenders are only allowed to charge borrowers' a maximum of 10% interest on any loans. We believe this creates fair agreements for both the borrower's and lenders.
When lending your money, you should always be thinking about setting fair terms for your friend and family member. This not only includes the interest you charge but how long they have to repay. This will help you get your money back, and make sure your relationships stay intact.
Punk Money is a great platform for friend and family loans. You can build fair loan agreements in just a few minutes, and we’ll handle all the legal docs and automate the repayments to make life easier.